Although the combined company will command a whopping 81 percent of the U.S. retail PC market, the merger won't erase the problems that drove HP and Compaq to combine--namely, that Dell can make PCs for less than either company.

The merger, ideally, will make HP-Compaq more efficient by cutting duplicative costs, but Dell will likely be able to undercut that. In addition, HP will have its hands full trying to integrate two huge bureaucracies and two very different strategies for manufacturing PCs. In short, the combined company will be about as big in PCs as Dell is, but not as profitable.

"There has been some fog (that) this combined company would be a major challenger to Dell--that's just baloney," said Forrester Research analyst Charles Rutstein. "Dell is efficient because they are Dell, because of the way they go to market--the direct model--and because (of) the way they do build-to-order manufacturing...Putting together two weakened PC companies--Compaq and HP--is not going to yield a Dell competitor."

The greatest problem HP and Compaq face is Dell's manufacturing strategy. Through its build-to-order manufacturing capability, Dell has managed to cut many of the risks of the PC business. The company can survive on lower inventories and take advantage of price cuts more quickly than competitors. Selling PCs directly to customers also cuts costs by eliminating dealer markup.

As separate companies, HP and Compaq have different strategies for taking on Dell. HP has outsourced virtually all of its manufacturing to contractors, according to several HP executives. Contract manufacturing reduces inventory costs but can be more expensive than in-house manufacturing because of the profit needs of contractors.

By contrast, Compaq has tried for years to construct its own build-to-order system. Last January, for instance, Compaq paid $370 million to buy Inacom's distribution and configuration capabilities. Both Compaq and HP also began to sell more PCs to large corporate customers directly, although the two companies still sell PCs through dealers and distributors.

Tough decisions
One of the first decisions HP will have to make is whether to continue with its outsourcing strategy, move to a build-to-order model or try to combine the two. That won't be easy.

"Dell must be totally gleeful because these guys are going to spend all of their time untangling themselves," said IDC analyst Roger Kay.

The hybrid direct-retail strategy could cause a drag. "As long as you have more than a distribution model, you are not cost competitive," Kay said. In the end, the two companies may have chosen to merge out of fear they would be exiled from the business anyway.

At best, HP and Compaq are betting that by combining administration, marketing and other departments, the conglomerate can drastically cut its fixed costs without losing market share. Historically, however, companies lose some market share and revenue after a merger; the combined entity usually shrinks in size before it can grow again.

"It is the triumph of pragmatism over pride," said Context analyst Jeremy Davies. "For Compaq, it must have been a difficult decision...In effect, it's the end of Compaq. It's saying, 'Run the numbers.' So they ran the numbers and concluded, 'We can't do this by ourselves.'

"It's the end of an era," Davies said. "You had the fastest-growing company that the Fortune 500 had ever seen when they started in 1984. What a short life span--Compaq: 1984-2001."

The combined company also won't have a lot of wiggle room. In the second quarter, Compaq's PC division lost $155 million, and $82 million the quarter before that. HP, meanwhile, saw revenue for its computing systems segment drop 22 percent in its third fiscal quarter. The division reported negative operating margins.

Dell, by contrast, made money on PCs during this period.

"Even with the transaction's cost synergies, it is probable that Dell will remain the cost leader and the new entity's margins will continue to be under pressure," Andy Neff, an analyst with Bear Stearns, wrote in a research note Tuesday.

A Dell representative said the company would not comment on the Compaq-HP merger.

For the first six months of the year, HP accounted for 41.8 percent of U.S. retail notebook and desktop PC sales, while Compaq generated 34.1 percent of sales, according to NPD Intelect. In desktop PCs, it is even more dramatic, with the two companies combining for 81.2 percent of retail sales.

"They have always been, in the desktop and notebook space, each other's biggest competition," said Matt Sargent, an analyst with market researcher ARS. "This is going to make life very tough for a lot of the other competitors."

Another key measure of retail strength is the amount of space each company commands on store shelves. On the desktop side, Compaq had 33.5 percent in August and HP had 32.9 percent, according to ARS. What's more, the nearest competitors are Micron Electronics, which is pulling back from the retail market, and Apple Computer, whose market is separate from Windows-based PCs.

A merger would hurt retailers, which depend on marketing dollars from the two PC giants to create their ads and draw customers to stores.

"If you look at the circulars every weekend, typically there are two or three pages of PC ads," said NPD Intelect analyst Stephen Baker. "Those are funded by the (computer makers) in concert with the processor makers."

The lack of competition could also drive prices higher, both Baker and Sargent said. HP and Compaq might not be that brutal in lowering prices in a comparatively weak market.

"I'm not sure how aggressive they will be going after each other," Baker said.

Then again, the lack of competition at retail will likely prompt Dell and Gateway to funnel far more energy into consumer sales. "Dell is hitting the consumer market like gangbusters," said Kay.

HP and Compaq said Compaq brand names will survive in certain, unspecified markets. Sargent said the companies might be wise to try and preserve both lines, perhaps by segmenting them along price lines.

HP's "Pavillion has seemed to have done better at the high end, where (Compaq's) Presarios have done better at the low-end," Sargent said.

The printer market is another area where the merged company will dominate. So far this year, HP has garnered 54.8 percent of the U.S. retail printer market, Baker said. If HP is able to add Compaq's 9.3 percent share, it will be even more dominant, Baker said--a potential issue for antitrust regulators.

"I suspect these are the places the government is going to look at, since it defines markets (pretty) narrowly," Baker said.

Chipmaker Advanced Micro Devices could also feel collateral effects of the merger. HP and Compaq are the main consumers of AMD processors. If the combined company decides to champion the company's chips, AMD could see its chips enter the business market as well as take over more of retail.

Then again, if the conglomerate chooses to de-emphasize AMD processors, the Sunnyvale, Calif.-based chipmaker won't have a strong alternative customer. The next-biggest buyer of AMD chips in the United States is Gateway, which has experienced its share of troubles.

Dell's problems
Dell, though, has to contend with its own problems. PC prices continue to drop, and the company still gains most of its money from selling hardware. For the past few years, it has expanded into storage and services, but it is a long way from enjoying the same sort of influence in these markets that it has in PCs.

The effort hasn't been entirely smooth, either. Dell acquired ConvergeNet in 1999 to jump-start its storage effort. It is the only acquisition in Dell's history. This summer, Dell shut down its Silicon Valley office, where ConvergeNet was based. Recently, it also transferred a Web hosting business to Sprint.

"They (Dell) are going to continue that march up into the enterprise. They're just going to take a very different tack than Compaq and HP have," Forrester's Rutstein said. "But they are capped at a certain point (because of services). The question is (whether) we will see Dell teaming up with some other services player, a Dell-EDS or a Dell-Unisys. That to me seems entirely likely."

Although the combined company will command a whopping 81 percent of the U.S. retail PC market, the merger won't erase the problems that drove HP and Compaq to combine--namely, that Dell can make PCs for less than either company.

The merger, ideally, will make HP-Compaq more efficient by cutting duplicative costs, but Dell will likely be able to undercut that. In addition, HP will have its hands full trying to integrate two huge bureaucracies and two very different strategies for manufacturing PCs. In short, the combined company will be about as big in PCs as Dell is, but not as profitable.

"There has been some fog (that) this combined company would be a major challenger to Dell--that's just baloney," said Forrester Research analyst Charles Rutstein. "Dell is efficient because they are Dell, because of the way they go to market--the direct model--and because (of) the way they do build-to-order manufacturing...Putting together two weakened PC companies--Compaq and HP--is not going to yield a Dell competitor."

The greatest problem HP and Compaq face is Dell's manufacturing strategy. Through its build-to-order manufacturing capability, Dell has managed to cut many of the risks of the PC business. The company can survive on lower inventories and take advantage of price cuts more quickly than competitors. Selling PCs directly to customers also cuts costs by eliminating dealer markup.

As separate companies, HP and Compaq have different strategies for taking on Dell. HP has outsourced virtually all of its manufacturing to contractors, according to several HP executives. Contract manufacturing reduces inventory costs but can be more expensive than in-house manufacturing because of the profit needs of contractors.

By contrast, Compaq has tried for years to construct its own build-to-order system. Last January, for instance, Compaq paid $370 million to buy Inacom's distribution and configuration capabilities. Both Compaq and HP also began to sell more PCs to large corporate customers directly, although the two companies still sell PCs through dealers and distributors.

Tough decisions
One of the first decisions HP will have to make is whether to continue with its outsourcing strategy, move to a build-to-order model or try to combine the two. That won't be easy.

"Dell must be totally gleeful because these guys are going to spend all of their time untangling themselves," said IDC analyst Roger Kay.

The hybrid direct-retail strategy could cause a drag. "As long as you have more than a distribution model, you are not cost competitive," Kay said. In the end, the two companies may have chosen to merge out of fear they would be exiled from the business anyway.

At best, HP and Compaq are betting that by combining administration, marketing and other departments, the conglomerate can drastically cut its fixed costs without losing market share. Historically, however, companies lose some market share and revenue after a merger; the combined entity usually shrinks in size before it can grow again.

"It is the triumph of pragmatism over pride," said Context analyst Jeremy Davies. "For Compaq, it must have been a difficult decision...In effect, it's the end of Compaq. It's saying, 'Run the numbers.' So they ran the numbers and concluded, 'We can't do this by ourselves.'

"It's the end of an era," Davies said. "You had the fastest-growing company that the Fortune 500 had ever seen when they started in 1984. What a short life span--Compaq: 1984-2001."

The combined company also won't have a lot of wiggle room. In the second quarter, Compaq's PC division lost $155 million, and $82 million the quarter before that. HP, meanwhile, saw revenue for its computing systems segment drop 22 percent in its third fiscal quarter. The division reported negative operating margins.

Dell, by contrast, made money on PCs during this period.

"Even with the transaction's cost synergies, it is probable that Dell will remain the cost leader and the new entity's margins will continue to be under pressure," Andy Neff, an analyst with Bear Stearns, wrote in a research note Tuesday.

A Dell representative said the company would not comment on the Compaq-HP merger.

For the first six months of the year, HP accounted for 41.8 percent of U.S. retail notebook and desktop PC sales, while Compaq generated 34.1 percent of sales, according to NPD Intelect. In desktop PCs, it is even more dramatic, with the two companies combining for 81.2 percent of retail sales.

"They have always been, in the desktop and notebook space, each other's biggest competition," said Matt Sargent, an analyst with market researcher ARS. "This is going to make life very tough for a lot of the other competitors."

Another key measure of retail strength is the amount of space each company commands on store shelves. On the desktop side, Compaq had 33.5 percent in August and HP had 32.9 percent, according to ARS. What's more, the nearest competitors are Micron Electronics, which is pulling back from the retail market, and Apple Computer, whose market is separate from Windows-based PCs.

A merger would hurt retailers, which depend on marketing dollars from the two PC giants to create their ads and draw customers to stores.

"If you look at the circulars every weekend, typically there are two or three pages of PC ads," said NPD Intelect analyst Stephen Baker. "Those are funded by the (computer makers) in concert with the processor makers."

The lack of competition could also drive prices higher, both Baker and Sargent said. HP and Compaq might not be that brutal in lowering prices in a comparatively weak market.

"I'm not sure how aggressive they will be going after each other," Baker said.

Then again, the lack of competition at retail will likely prompt Dell and Gateway to funnel far more energy into consumer sales. "Dell is hitting the consumer market like gangbusters," said Kay.

HP and Compaq said Compaq brand names will survive in certain, unspecified markets. Sargent said the companies might be wise to try and preserve both lines, perhaps by segmenting them along price lines.

HP's "Pavillion has seemed to have done better at the high end, where (Compaq's) Presarios have done better at the low-end," Sargent said.

The printer market is another area where the merged company will dominate. So far this year, HP has garnered 54.8 percent of the U.S. retail printer market, Baker said. If HP is able to add Compaq's 9.3 percent share, it will be even more dominant, Baker said--a potential issue for antitrust regulators.

"I suspect these are the places the government is going to look at, since it defines markets (pretty) narrowly," Baker said.

Chipmaker Advanced Micro Devices could also feel collateral effects of the merger. HP and Compaq are the main consumers of AMD processors. If the combined company decides to champion the company's chips, AMD could see its chips enter the business market as well as take over more of retail.

Then again, if the conglomerate chooses to de-emphasize AMD processors, the Sunnyvale, Calif.-based chipmaker won't have a strong alternative customer. The next-biggest buyer of AMD chips in the United States is Gateway, which has experienced its share of troubles.

Dell's problems
Dell, though, has to contend with its own problems. PC prices continue to drop, and the company still gains most of its money from selling hardware. For the past few years, it has expanded into storage and services, but it is a long way from enjoying the same sort of influence in these markets that it has in PCs.

The effort hasn't been entirely smooth, either. Dell acquired ConvergeNet in 1999 to jump-start its storage effort. It is the only acquisition in Dell's history. This summer, Dell shut down its Silicon Valley office, where ConvergeNet was based. Recently, it also transferred a Web hosting business to Sprint.

"They (Dell) are going to continue that march up into the enterprise. They're just going to take a very different tack than Compaq and HP have," Forrester's Rutstein said. "But they are capped at a certain point (because of services). The question is (whether) we will see Dell teaming up with some other services player, a Dell-EDS or a Dell-Unisys. That to me seems entirely likely."

Although the combined company will command a whopping 81 percent of the U.S. retail PC market, the merger won't erase the problems that drove HP and Compaq to combine--namely, that Dell can make PCs for less than either company.

The merger, ideally, will make HP-Compaq more efficient by cutting duplicative costs, but Dell will likely be able to undercut that. In addition, HP will have its hands full trying to integrate two huge bureaucracies and two very different strategies for manufacturing PCs. In short, the combined company will be about as big in PCs as Dell is, but not as profitable.

"There has been some fog (that) this combined company would be a major challenger to Dell--that's just baloney," said Forrester Research analyst Charles Rutstein. "Dell is efficient because they are Dell, because of the way they go to market--the direct model--and because (of) the way they do build-to-order manufacturing...Putting together two weakened PC companies--Compaq and HP--is not going to yield a Dell competitor."

The greatest problem HP and Compaq face is Dell's manufacturing strategy. Through its build-to-order manufacturing capability, Dell has managed to cut many of the risks of the PC business. The company can survive on lower inventories and take advantage of price cuts more quickly than competitors. Selling PCs directly to customers also cuts costs by eliminating dealer markup.

As separate companies, HP and Compaq have different strategies for taking on Dell. HP has outsourced virtually all of its manufacturing to contractors, according to several HP executives. Contract manufacturing reduces inventory costs but can be more expensive than in-house manufacturing because of the profit needs of contractors.

By contrast, Compaq has tried for years to construct its own build-to-order system. Last January, for instance, Compaq paid $370 million to buy Inacom's distribution and configuration capabilities. Both Compaq and HP also began to sell more PCs to large corporate customers directly, although the two companies still sell PCs through dealers and distributors.

Tough decisions
One of the first decisions HP will have to make is whether to continue with its outsourcing strategy, move to a build-to-order model or try to combine the two. That won't be easy.

"Dell must be totally gleeful because these guys are going to spend all of their time untangling themselves," said IDC analyst Roger Kay.

The hybrid direct-retail strategy could cause a drag. "As long as you have more than a distribution model, you are not cost competitive," Kay said. In the end, the two companies may have chosen to merge out of fear they would be exiled from the business anyway.

At best, HP and Compaq are betting that by combining administration, marketing and other departments, the conglomerate can drastically cut its fixed costs without losing market share. Historically, however, companies lose some market share and revenue after a merger; the combined entity usually shrinks in size before it can grow again.

"It is the triumph of pragmatism over pride," said Context analyst Jeremy Davies. "For Compaq, it must have been a difficult decision...In effect, it's the end of Compaq. It's saying, 'Run the numbers.' So they ran the numbers and concluded, 'We can't do this by ourselves.'

"It's the end of an era," Davies said. "You had the fastest-growing company that the Fortune 500 had ever seen when they started in 1984. What a short life span--Compaq: 1984-2001."

The combined company also won't have a lot of wiggle room. In the second quarter, Compaq's PC division lost $155 million, and $82 million the quarter before that. HP, meanwhile, saw revenue for its computing systems segment drop 22 percent in its third fiscal quarter. The division reported negative operating margins.

Dell, by contrast, made money on PCs during this period.

"Even with the transaction's cost synergies, it is probable that Dell will remain the cost leader and the new entity's margins will continue to be under pressure," Andy Neff, an analyst with Bear Stearns, wrote in a research note Tuesday.

A Dell representative said the company would not comment on the Compaq-HP merger.

For the first six months of the year, HP accounted for 41.8 percent of U.S. retail notebook and desktop PC sales, while Compaq generated 34.1 percent of sales, according to NPD Intelect. In desktop PCs, it is even more dramatic, with the two companies combining for 81.2 percent of retail sales.

"They have always been, in the desktop and notebook space, each other's biggest competition," said Matt Sargent, an analyst with market researcher ARS. "This is going to make life very tough for a lot of the other competitors."

Another key measure of retail strength is the amount of space each company commands on store shelves. On the desktop side, Compaq had 33.5 percent in August and HP had 32.9 percent, according to ARS. What's more, the nearest competitors are Micron Electronics, which is pulling back from the retail market, and Apple Computer, whose market is separate from Windows-based PCs.

A merger would hurt retailers, which depend on marketing dollars from the two PC giants to create their ads and draw customers to stores.

"If you look at the circulars every weekend, typically there are two or three pages of PC ads," said NPD Intelect analyst Stephen Baker. "Those are funded by the (computer makers) in concert with the processor makers."

The lack of competition could also drive prices higher, both Baker and Sargent said. HP and Compaq might not be that brutal in lowering prices in a comparatively weak market.

"I'm not sure how aggressive they will be going after each other," Baker said.

Then again, the lack of competition at retail will likely prompt Dell and Gateway to funnel far more energy into consumer sales. "Dell is hitting the consumer market like gangbusters," said Kay.

HP and Compaq said Compaq brand names will survive in certain, unspecified markets. Sargent said the companies might be wise to try and preserve both lines, perhaps by segmenting them along price lines.

HP's "Pavillion has seemed to have done better at the high end, where (Compaq's) Presarios have done better at the low-end," Sargent said.

The printer market is another area where the merged company will dominate. So far this year, HP has garnered 54.8 percent of the U.S. retail printer market, Baker said. If HP is able to add Compaq's 9.3 percent share, it will be even more dominant, Baker said--a potential issue for antitrust regulators.

"I suspect these are the places the government is going to look at, since it defines markets (pretty) narrowly," Baker said.

Chipmaker Advanced Micro Devices could also feel collateral effects of the merger. HP and Compaq are the main consumers of AMD processors. If the combined company decides to champion the company's chips, AMD could see its chips enter the business market as well as take over more of retail.

Then again, if the conglomerate chooses to de-emphasize AMD processors, the Sunnyvale, Calif.-based chipmaker won't have a strong alternative customer. The next-biggest buyer of AMD chips in the United States is Gateway, which has experienced its share of troubles.

Dell's problems
Dell, though, has to contend with its own problems. PC prices continue to drop, and the company still gains most of its money from selling hardware. For the past few years, it has expanded into storage and services, but it is a long way from enjoying the same sort of influence in these markets that it has in PCs.

The effort hasn't been entirely smooth, either. Dell acquired ConvergeNet in 1999 to jump-start its storage effort. It is the only acquisition in Dell's history. This summer, Dell shut down its Silicon Valley office, where ConvergeNet was based. Recently, it also transferred a Web hosting business to Sprint.

"They (Dell) are going to continue that march up into the enterprise. They're just going to take a very different tack than Compaq and HP have," Forrester's Rutstein said. "But they are capped at a certain point (because of services). The question is (whether) we will see Dell teaming up with some other services player, a Dell-EDS or a Dell-Unisys. That to me seems entirely likely."